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The last sustained bear market in the US occurred during the Great Recession of 2007 to 2009. This means that many new investors today may have never experienced a true bear market before.
This is because historically bull markets have lasted significantly longer. But no market – bear or bull – lasts forever. The question is: Once the bear is caught, how will you survive until the bull returns?
What is a bear market?
A bear market occurs when broad market indexes, such as the S&P 500 and Nasdaq Composite, fall 20% or more. By the time this threshold is reached, the bear market may have already done significant damage to your portfolio.
“When you have a bear market, the bear will end up grabbing quite a bit before the bear market is even paid off,” said Quincy Crosby, chief global strategist at LPL Financial.
U.S. stocks have been in a bear market for most of 2022, although there was a significant uptick in the bear market over the summer.
“This time, it wasn’t until the big tech names — with a 21% weight in the S&P 500 — were taken down that a bear market was declared,” says Crosby.
How long does a bear market last?
Bear markets usually last about 15 months. According to data from the Schwab Center for Financial Research, the longest record lasted 2.5 years, while the shortest was just 33 days, in early 2020 at the start of the Covid-19 pandemic.
When it comes to determining the causes, bear markets are complex and multifaceted. Historical examples include economic crises such as the subprime crisis of 2008 and the Dot Com bubble of the early 2000s.
The 2022 bear market was triggered by high inflation, which forced global central banks to tighten monetary policy to cool price growth. Unfortunately, it also plunged stocks deep into the red, and many commentators worry that a recession is just around the corner.
Because bear markets are not short-term phenomena, it’s important to remain open that short-term pullbacks in the stock market can always turn into a bear market — and prepare your portfolio to weather the storm.
“The sooner people reevaluate their investments and incorporate new strategies, the better,” Tim Pagliara, chairman and chief investment officer at CapWealth, said. “The next ten years will not be like the last ten.”
Bear markets affect more than stocks
Although bonds are less volatile than stocks, they can also experience prolonged drawdowns and losses. It is entirely possible, though rare, for bear markets in stocks and bonds to occur at the same time.
While this is usually an anomaly, this is the scenario that played out in 2022. At that time, the macro environment was difficult even for diversified portfolios.
However, fixed income markets have since stabilized and proved to be a safe haven for weary investors.
How to invest during a bear market
Investing during a bear market doesn’t have to be complicated. Maintaining diversification, maintaining a long-term perspective, being mindful of acceptable risks and avoiding bad investment behavior are the keys to success.
Here are some tips on how to invest during a bear market.
1. Rebalance your portfolio
A diversified portfolio consists of multiple asset classes such as stocks, bonds and cash. The ratio of each asset should be maintained according to your time horizon, risk tolerance and investment objectives.
Portfolio rebalancing generally means periodically selling overweight assets and buying underweight assets until your portfolio returns to its target asset allocation. However, during a bear market, “…rebalancing can now include asset classes that you didn’t own before, such as short-term bonds or maybe even long-term fixed income assets,” Pagliara says.
Of course, you may end up selling winners and buying losers, which may seem illogical. But you need to make sure that your portfolio composition matches your desired risk tolerance and investment goals.
2. Use Tax-Loss Harvesting
You can lower your tax bill while staying invested through tax loss harvesting. This is the practice of strategically selling investments in a taxable loss brokerage account and offsetting capital losses against capital gains or income tax.
You can reduce your taxable capital gains and offset up to $3,000 of your income. This is a great way to capitalize on your losses during a bear market.
But an important thing about tax loss harvesting is the wash sale rule. When you sell equity at a loss, you cannot buy it back or another “substantially identical” security within the next 30 days. This means you could be missing out on a potential bounce.
3. Own risk assets
A bear market is a good time to assess whether your portfolio’s asset allocation really meets your risk tolerance. Of course, Palyara says, everything carries risk. The question is simply which assets carry the most risk right now.
If volatility in your portfolio is keeping you up at night, consider a greater allocation to the following more traditionally risk-averse assets:
Short-term government bonds
Treasury bills, also known as Treasury bills, are bonds issued by the US government with maturities ranging from a few days to 52 weeks. They are universally considered a “risk-free” asset for two reasons:
- No credit risk: Unlike corporate bonds, government bonds are backed by the full faith and credit of the U.S. government.
- Very low risk: All bonds have a duration, a measure of their sensitivity to interest rate changes.
Certificates of Deposit
A certificate of deposit (CD) is a savings product offered by banks that promises both security of principal and periodic interest payments for a fixed time.
An investor who buys a CD commits to locking in their initial investment for a certain period of time, such as six months, a year, two years, or even five years. In return, the CD pays monthly or semiannual interest. At maturity, you cash out the CD in exchange for your original investment.
Unlike bonds, CDs have no interest rate risk. If prices go up, your CD won’t lose value or earn extra profit, but new CDs may pay more competitive prices.
The downside is that CDs don’t allow you to withdraw your money before maturity. If they do, there may be early withdrawal penalties. The drives are also insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per account.
Buying an annuity can be a good idea for low-risk investors. The most conservative type of annuity to purchase is a fixed annuity. Unlike variable annuities, fixed annuities are not linked to stock market performance.
During the accumulation phase, the investor makes contributions. Later, the annuity starts during the distribution phase, where the investor receives a fixed rate of return for a certain number of years.
4. Buy Dip and stay on course
If you already own a diversified portfolio, dollar cost averaging is a good practice. Dollar cost averaging is when investors put the same amount of money into their portfolios over specific time periods.
“With dollar cost averaging, you have the ability to be flexible, which becomes more important in an environment like this,” Pagliara says.
However, dollar cost averaging is not market timing. The reality is that bear markets can be unpredictable and prone to numerous false rallies known as “bear traps.”
“There are always pockets of hope that attract investors who think the bear market is over,” says Crosby. That’s why it’s always a good idea to maintain the pace and size of your investment contributions.
Long-term investors know that bear markets are to be expected. They are a necessary part of the economic cycle. They just tend to be less common and shorter-lived than their bull market counterparts.
“In the current bear market, the Fed has a job to do, and that is to restore price stability,” Crosby says. “It’s not like 2008-09 or even the tech bubble that’s going on.”
While bear markets are an inevitable part of investing, they don’t have to be painful. By owning a diversified portfolio and practicing good investment behavior, investors can survive and even thrive during them.
The best practice is to take a long-term view and stay the course.